Econocasts

Saturday, May 10, 2014

The VIX cycle model suggests a rising VIX over the rest of the year. The busy chart above shows a "Z-score" on the right axis. This is a measure of how far off the model is from reality, looking backwards. If the prediction and actual price were equal, the z-score would be zero. If the predicted price is higher than the actual price, the z-score is positive, and vice versa. Each of the units on the z-score is one standard deviation, so you can ask the question "Over the history of the time series, what percentage of the time does the predicted price deviate from the actual price in a negative or positive fashion by that amount?" Notice that I have blue bars at the bottom of the chart. These illustrate time points where the z-score deviated more than two standard deviation units, so that the actual price was lower than the predicted price. In every single instance, the actual price quickly corrected upwards. Of course the same argument can also be made in reverse. So we shall see.